A strategy’s success is dependent on three key factors: alignment with the external environment, an internal view of core competencies and sustainable competitive advantage, and careful implementation.
A solid strategic plan will include metrics that can translate the vision or mission into specific goals and objectives . This is crucial because strategic planning is ultimately about resource allocation. It would not be useful if there were no resources. This article discusses how finance, financial goals and financial performance can play an integral part in strategic planning and decision-making, especially in the implementation and monitoring stages.
Strategic-Planning and Decision-Making
1. Vision Statement
The first step in strategic-planning is to create a vision statement. This statement should describe the company’s core ideologies, why it exists, and its vision for the future.
2. Mission Statement
Effective mission statements communicate eight key components about the business: target customers and markets, main products, services, geographic domain, core technology, commitment to growth and survival; philosophy; self-concept and desired public image.
The third step is to analyze the firm’s business patterns, external opportunities, internal resource and core competencies. The third step is an analysis of the firm’s business trends, external opportunities, internal resources, and core competencies.
The industry evolution model can be used to identify takeoff (technology, quality and performance), rapid growth, early maturity, slowing growth (cost reductions, value services and aggressive strategies to maintain or increase market share), saturation in the market (elimination of marginal products and continual improvement of the value-chain activities), stagnation or decline (redirection of efforts to be a low cost industry leader and/or redirected to fastest-growing segments), and stagnation or decline.
Value-chain analysis is another method that clarifies a company’s value-creation processes based on its primary activities.
4. Strategy Formulation
Porter’s generic strategies model helps to develop a long-term strategy.
5. Strategy Implementation and Management
The balanced scorecard , which helps to align strategy and performance, has been one of the most useful management instruments in implementing and monitoring strategy execution.
For evaluating a firm’s performance, financial metrics have been the standard. The BSC helps finance to establish and monitor specific, measurable financial strategic objectives on a coordinated, integrated basis. This will allow the firm’s efficiency and effectiveness. The BSC establishes financial metrics and goals based on benchmarking “best-in industry” and includes:
1. Free cash flow
This is a measure for the firm’s financial soundness. It shows how well its financial resources have been utilized to generate additional capital for future investments. After subtracting investments and working capital, it represents the firm’s net cash. This is a useful metric for companies that anticipate large capital expenditures or need to monitor the progress of projects.
2. Economic Value-Added
This is the bottom-line contribution, calculated on a risk adjusted basis. It helps management make timely decisions to expand businesses that will increase the firm’s value. To accurately assess the value of their businesses and improve resource allocation, companies establish economic value-added objectives.
3. Asset Management
This means that current assets (cash and receivables) and liabilities (payables, accruals, inventory) must be managed efficiently. Additionally, it requires a better management of cash conversion cycles and working capital. When their operating performance is below the industry benchmarks, or benchmarked companies, they must use this method.
4. Financial Decisions and Capital Structure
The optimal capital structure, also known as leverage or debt ratio, is the one that allows for financing. This refers to the level that reduces the firm’s capital costs. This optimal capital structure defines the firm’s reserves borrowing capacity (short and long-term), and the risk for financial distress. Companies set up this structure when their capital costs rise above those of direct competitors and they lack new investments.
5. Profitability Ratio
This measures the efficiency of an organization’s operations. It is used to identify inefficient areas and require management action. If companies want to improve their profitability ratios and operate more efficiently, they should set goals.
6. Growth Indices
Growth indices are used to evaluate the growth of sales and market share and to decide the appropriate trade-off between growth and reductions in cash flow, profit margins, or returns on investment. Growth is a drain on cash and reserves borrowing funds. Companies should set growth index goals when their growth rates are below industry norms or when they have high operating debt.
7. Risk Assessment and Management
It is essential that a firm addresses its key uncertainties by identifying and measuring its risks in corporate governance, regulatory compliance, their likelihood of occurring, and their economic consequences. A process must then be developed to minimize the effects and causes of these risks.
8. Tax Optimization
Many areas of business and functions need to consider the impact of tax on their business. Performance should be measured after tax whenever possible. This measure must be adopted by global companies when they operate in different tax environments.
The introduction and use of the balanced scorecard made financial performance a key indicator of success for a business. This helped to tie strategic goals to performance, provide timely and useful information to enable strategic and operational control decisions. This has increased the importance of finance in strategic planning.
Empirical research has shown that most corporate strategies fail to be implemented. These financial metrics are used to help companies implement and track their strategies. They also assist in setting and measuring specific industry-specific financial goals. They provide sustainable competitive advantages that increase a firm’s value, which is the ultimate goal of all stakeholders.